Fundamental Analysis in Crypto: All You Need to Know
Cryptocurrency has been a hot topic in the world of finance for the past few years. With its meteoric rise and subsequent volatility, it’s no surprise that people are interested in learning more about it. Fundamental analysis is an important tool for understanding and investing in cryptocurrencies. In this blog, we will provide a comprehensive overview of fundamental analysis in the context of cryptocurrencies and explain the key metrics used to measure the performance and potential of a cryptocurrency.
Whether you are a seasoned trader or just starting to explore the world of cryptocurrency, this post will provide valuable insights into the key metrics that can help you make better trading decisions.
Context of What Fundamental Analysis Is
Particularly in crypto, fundamental analysis (FA) is a method used to evaluate the intrinsic value of a cryptocurrency. This approach uses a bigger-picture mindset to help evaluate the cryptocurrency by looking at the community, financials, real-world applications, and future use cases. Traditional fundamental indicators used to assess stocks don’t work well with cryptocurrencies. Instead, taking a different approach when analyzing fundamental factors for cryptocurrencies is essential.
For beginning purposes, let’s look at three crypto FA metrics categories: project, financial, social metrics.
Unlike financial factors, project metrics are qualitative rather than quantitative that can provide insight into a crypto project. These metrics often deal with the development side of a project, looking at how it works, and what problem it promises to solve.
Most projects have a whitepaper - a comprehensive document containing important information about the crypto project. A good whitepaper should define the project's goals and give us an insight into the project’s future plans.
Here are some things to look out for in the whitepaper that can be useful in analyzing the project are the following:
- The RoadMap: Is there a clear long-term strategy for the project? A thought-out roadmap can be a good sign that the founders are in it for the long term. Alternatively, a project without a roadmap can be a red flag, depending on the project's intentions. Additionally, a roadmap can provide insight into if the project is reaching its timelines and, if not, communicate the reason why with its token holders.
- Mission: Every project should have a goal that should be clear in the whitepaper. Even if the project is meant to be a joke without some utility, it should be stated in the whitepaper, so potential investors and traders are not misled.
- How does the project work?: A good white paper should be able to explain how the technology will work, and the best white papers do so with varying levels of complexity and technical knowledge required. For example, is the technology open-sourced or closed-sourced? Open source projects embrace transparency, open exchange, free participation, rapid prototyping, and community-oriented, collaborative development. These types of projects are seen with DAOs. Close-sourced projects are projects whose source code is not published, and only the person, team, or organization who created it has the right to modify and distribute it.
Another critical metric to look out for is information on the team & founders of the project. Have the founders undertaken successful ventures in this industry? Do they have previous experience in being able to accomplish their goals. What about being involved in any questionable projects or scams? You should look out for these things when looking at the team.
Sometimes projects don’t have a team. Instead, it’s a community-driven project. If that’s the case, if the project has a Git hub, check to see how many contributors there are and how much activity is going on. A project with many contributors and lots of activity can be considered reasonable.
Understanding the project’s goal, given the current competitors, is essential. It’s highly recommended that you research these competitors as well. If there are already highly established competitors in the marketplace, the project can have challenges to succeed. On the other hand, if these competitors are not well-known, then the playing field is even, and a better chance of success.
Knowing as much as you can about the competitors will provide insight into the likelihood that the company will succeed and be able to compete.
4. Economics of the Token
A good project will explain the economics of the token, which will help detail the purpose, utility, and token distribution. Understanding the economics of a token should provide traders & investors with insight if the token has a sustainable and viable business model.
Traders & investors should make sure to solve these questions when researching the economics of the project:
- Does it have an inflationary or deflationary plan?
- How does it plan to add more tokens into circulation if it chooses to?
- How does it plan to burn the ones in circulation when needed?
- Does the token provide utilities (benefits) such as membership perks and governance ability?
All these questions can impact the token’s price depending on how the project wishes to respond. For example, many tokens have a vesting schedule - a way to control the release of tokens to ensure that they are not all dumped on the market at once. After a certain period, the tokens that are locked away are released into the market, impacting the token's supply and price. It’s essential to keep in mind vesting schedules when trading tokens.
Another important aspect of fundamental analysis is financial metrics. These metrics can provide traders with a better understanding of the health and potential of a cryptocurrency by analyzing quantitative data. Here are some of the key financial metrics to keep in mind.
1. Market Capitalization
In crypto, market capitalization (market cap) refers to the total market value of a cryptocurrency. It can be calculated by multiplying the number of coins in circulation by the current market price of the coin. The market capitalization of a cryptocurrency can highlight the coin's stability in the long run.
Especially in crypto, which is known for its volatility, cryptocurrencies with large market caps usually indicate that these coins are more stable and have a more established presence than coins with smaller market caps. However, small-cap coins can experience an upside in growth and extreme fluctuations in price changes. Understanding market capitalization can be an excellent tool for smarter trading decisions.
Liquidity measures how easily an asset can be bought or sold without causing significant price movements. Generally, a token that is considered to be highly liquid is considered a positive characteristic of a cryptocurrency. A highly liquid cryptocurrency has many active buyers and sellers, which means it is easier to buy or sell the asset at its current market price without significantly affecting that price.
On the other hand, a cryptocurrency with low liquidity may be difficult to buy or sell without affecting the market price and may result in slippage or wider bid-ask spreads. This is why many traders and investors consider liquidity when choosing which cryptocurrencies to trade and even the exchanges and trading pairs they use.
In crypto trading, volume refers to the total amount of a particular cryptocurrency bought or sold over a given period. It is a measure of the trading activity for a specific cryptocurrency.
High trading volume indicates that a cryptocurrency is actively traded, which can indicate market interest and investor sentiment. It also means that there is a higher level of liquidity for that cryptocurrency, making it easier for traders to buy and sell the asset without affecting the market price too much. High trading volume can be a positive sign for a cryptocurrency, as it can attract more traders and investors and increase market efficiency.
Traders and investors often use trading volume as an important indicator of market activity and price movement, along with other metrics such as price charts, order book data, and technical indicators.
For cryptocurrencies, such as social tokens, financial metrics aren’t enough to evaluate the token's value. Social tokens are unique because they can help value the social capital, reputation, trust, and intangible value that a creator, brand, individual, or community contains. For these types of tokens, a different approach should be made to assess the social aspect of the token.
As a result, we recommended traders look at community-specific metrics such as community growth, governance activity, and resource allocation.
Fundamental analysis is an essential tool for evaluating cryptocurrencies, as it provides valuable insights into the underlying technology, market trends, and potential risks and opportunities. By analyzing both project metrics, such as the whitepaper, team, and competitors, and financial metrics, such as market capitalization, liquidity, and volume, traders and investors can better understand the long-term value proposition of a particular cryptocurrency. Moreover, fundamental analysis helps investors to distinguish between genuine innovations and hype-driven projects, which can mitigate the risk of investing in a speculative asset. Therefore, incorporating fundamental analysis into one's trading strategy can enhance their chances of making informed decisions and achieving long-term success in the fast-evolving world of cryptocurrency.
A basic understanding of the types of fundamental metrics mentioned in this article will provide you with more tools and insights for your trading strategy to help you achieve your trading goals. It’s important to note that not one metric alone will guarantee success, and the best crypto traders understand how to leverage fundamental analysis along with technical and on-chain analysis into their trading strategy to maximize profits.
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